Macro Strategy: Short EUR positions balloon; Asian vols still low

According to the US Commodity Future Trading Commission (CFTC), net short euro positions have increased to 27.4 million contracts last week, its largest since April 2017. Meanwhile, the Euro Stoxx 50 index has fallen to its lowest level since December 2016 and Italy’s 10Y bond yield has risen to 3.50% from 3% on Rome’s desire to push through a wider than enviaged budget deficit. The ECB is likely to take a stern tone on Italy for threatening the unity of the single market. The odds have increased for EUR/USD to break into a lower 1.10-1.15 range for the rest of the year, in our view.

This week’s expected rate hike in Canada will be instructive for currency markets. The Bank of Canada (BOC) is widely expected to raise rates by 25bps to 1.75% on October 24. CPI inflation has been above its official 2% target for eight straight months ending September. Viewed as a dovish hike, the Canadian dollar did not strengthen but depreciated past 1.30 ahead of this week’s monetary policy meeting. CPI had peaked at 3% YoY in July and retreated to 2.2% in September. Real GDP growth had also decelerated to 2.4% in July from 3% in March. On the other hand, the BOC Loan Officer Survey has cited increased confidence in the US economy for the strong investment intentions by Canadian corporates who also noted a tighter labour market. The Fed’s Beige Book Report on October 24 is likely to reaffirm the strong US economy as the reason for carrying on its stance to gradually hike rates. The BOC has been closest in matching Fed hikes. Hence, the weakness in the Canadian dollar will be synonymous with a stronger USD outlook.

Rates: Aside from the VIX, vols have been well-behaved

Aside from equity vols (the VIX), implied volatility (1M10Y USD swaption, 1M ATM EUR/USD & USD/JPY) across the other asset classes have been reasonably well-behaved. Over the course of the year, rising interest rates have frequently been blamed for weakening sentiment across risky assets. However, this argument misses out on broader economic risks as the US-China trade war ratchets up. Simplistically speaking, the VIX captures more of the negative narrative than the other measures of implied volatility do. Thus far this year, the VIX has been above 20 for 27 days (closing prices). Comparatively, the figure was zero in 2017. However, 2017 was an exceptional year where the environment was extremely conducive to take on risky assets and is unlikely to be repeated anytime soon. 2015 and 2016 are perhaps more representative. In those two years, the VIX was above 20 for 42 days each. Viewed this way, the VIX is high compared to 2017 but does not stand out when we compare to other years.

One would have thought that rising interest rates would spur higher implied vols across rates and fx. That has not been the case. Implied vols in USD swaptions have declined steadily through the year after the large spike to 80 in February. The recent push higher in USD rates barely resulted in a move to 62, negligible by any standard. As USD rates rise, they get closer to neutral. At which point, risks of further upside in rate become a lot less. For example, upside risks in USD rates should be higher when rates are low in absolute terms and vice versa in a Fed hike environment. This reasoning would flip (when we consider downside risks in the event of a US slowdown (similar to 2008) and how the Fed would react. For FX, implied vols for EUR/USD and USD/JPY have been largely in range. Instead, jitters are largely seen for the USD/CNY pair when vols are somewhat elevated.